The Real Message From Commodities

By Michael Pento | August 19, 2008 | 12:07 PM | 10 Comments

Wall Street wants you to believe that the recent fall in commodity prices stems from a rising dollar that is due to an improvement in the American economy. The truth is that the rebound in the dollar is solely due to falling foreign currencies caused by a substantial slowdown in global GDP rates. The truth is that the weakness in the US economy and housing market--with its affect on financial institutions and the market in general--is intensifying.

A rising US dollar would normally signal great news for the US economy because it brings down the cost of imported goods and is usually indicative of a return to positive interest rates and a hard currency policy. It also telegraphs that the domestic rate of inflation should be headed lower. However, the dollar's recent appreciation was not due to a change in monetary policy from the Fed, nor was the pullback in commodities the result of an imminent substantial increase in their supply. The retreat in almost every commodity across the board signals that demand has contracted sharply as the credit crisis diffuses worldwide.

For investors to claim that the strengthening dollar is indicative of better days ahead for the US economy is tantamount to saying a person who has contracted a severe air borne virus can cured by coughing on someone else. Investors may soon come to realize that global stagflation is not a reason to buy US equities.

There is a small possibility that the global economy is just slowing on the margin and that the selloff in commodities is unfounded and overdone.  The more likely scenario is that the selloff is due to demand destruction stemming from a severe contraction in global growth. If this is the case, not only should most commodities be avoided for the next few months (with the exception of gold) but also global equities. It was foolishness to believe that the US--currently representing over 21% of global GDP--could slow down and not affect global growth to a substantial degree. It is likewise folly to believe that global GDP can slow yet leave the US unaffected.  Emerging economies are clearly developing middle classes able to consume more of their own production, but that remains a story in progress.

The severe correction in global stock markets gives credence to the belief that the selloff in commodities is due to a demand destruction phenomenon.  This has given a short term boost to the dollar on the outlook that foreign central banks will soon slash rates. At this point in time dollar bulls can only hope that Jean Claude Trichet and Mervin King drink Ben Bernanke's monetary Kool-Aid, begin to ignore inflation while worrying instead about growth. The U.S. dollar has already priced in several rate reductions by the Bank of England and the European Central Bank. However, based on their statements investors should not be too quick to believe they will follow the same direction as our Fed. According to Bloomberg, Bank of England President Mervin King said on August 13^th "...the British economy is going through a difficult and painful adjustment...that cannot be avoided."

How refreshing it is to hear a central banker acknowledge his limitations and accept the consequences of the unwinding of an asset bubble. Contrast that statement, along with others that sound similar to his from ECB President Trichet, with policy emanating from Ben Bernanke. He's had the hubris to believe that the Fed can repeal the business cycle and will fight a recession at all cost.  Mr. Bernanke also has mistakenly predicted the US economy will recover in the second half in each year of his tenure and has stated repeatedly that the Fed must balance the risks between inflation and growth. Wouldn't it be nicer if Mr. Bernanke instead accepted that the economy is going to be weak and assent that there is nothing he can do about it.

Bottom line is that if foreign central bankers keep to their word, this dollar rebound will be very short lived. Neophyte dollar bulls who have recently crawled out of the wood work should realize that in the long term, key European central banks are doing what is necessary to fight inflation. By not debasing their currencies, these central bankers are providing an environment that is conducive to well-balanced growth instead of an economy that is based on the creation of rolling asset bubbles. And in doing so they have provided the only real prescription for a strong currency.

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Dollar Fake Out - likely As mentioned in previous and recent articles on this website, global growth has slowed, and the Dollar breakout is likely to be a fakeout. I don't believe the fundamentals support a strong dollar. The last "breakout" in the dollar was in May, 2005 and gold was at $400 and from that point, gold went on to $1000 in 2 years. As far as commodities are concerned, I think you will have a competing dynamic of negative real interest rates and lower global growth; therefore, commodities are ranged bound until growth picks up again in 12 to 18 months is my guess. I think oil and gold are at their lower ends of that price range. Technically, gold is not in a bear market yet; same for crude oil. They will need time to move to new highs. As far as central bankers go, they will inflate! That is their mandate. Is the selloff in commodities overdone? Probably not, but that doesn't mean their bull markets are over. Nothing ever grows to the sky and even markets need time to rest. Submitted by Guy M Lerner (not verified) on Tue, 2008/08/19 - 6:01pm » reply |

I'm back! Hello again Mike! Thanks for taking the time to explain the direct purchasing of treasury debt to me. So correct me if I'm wrong, what that means is that the government runs massive deficits in an attempt to reflate the economy, and instead of auctioning off treasuries to float the debt, they just have the Fed literally print money to pay it off? If I interpretted that correctly, then yes, that would be disastrous and we would be on our way to becoming like the Weimar Republic; however, I don't believe our government or our central bank is that suicidal because if they hyperinflated, the game would come to an end, for good. Submitted by Bulleri on Tue, 2008/08/19 - 3:00pm » reply |

Helicopter Ben will get a Helicopter Ben will get a new moniker once he's released from his position: Don Quixote. Both the BoE and ECB heads said it in plain English that inflation is their preoccupation. And oil has retreated some 20%+, yet gas prices in France for example, are only 10% down from their peak. The other 10% went for rebuilding profit margins. Thus don't expect to see rate cuts in Europe anytime soon while inflation remains well above target levels. And what do you think is the effect of a depreciating euro on the price of Chinese imports? You guessed it right: inflationary. Submitted by Anonymous (not verified) on Tue, 2008/08/19 - 1:23pm » reply |